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Will Xiaomi's Rise to the Top of the Chinese Smartphone Market Last?

A year ago, no one knew what Xiaomi was. Nowadays, anyone who pays any attention to the smartphone market has heard of Xiaomi's meteoric rise to the top of the enormous Chinese smartphone market.

In fact, market researcher Canalys just listed Xiaomi the No. 1 smartphone vendor in the Middle Kingdom after the company shipped 15 million units in the second quarter. That was enough to unseat Samsung, which shipped 13.2 million units.

Source: Canalys.

How did Xiaomi accomplish so much so quickly? More important, where is the company headed?

At the same time, Xiaomi sells its products at affordable prices. The company prefers to sell hardware close to cost, with the intent of making money on content and services after the initial sale. That has long been Amazon's historical hardware strategy (before its Fire Phone).

Quality devices at affordable prices? Sounds like a recipe for success.

Where Xiaomi goes from hereWithout a doubt, Xiaomi is riding high right now for all the right reasons. However, success in the smartphone market is notoriously difficult to sustain, and fortunes change hands very easily. That's especially true within the Android camp, as most hardware vendors have a hard time differentiating themselves from the competition and end up becoming commoditized.

Samsung has tried very hard to create new proprietary apps and services as a way to set itself apart from the Android crowd, with limited success. The South Korean conglomerate remains the largest handset maker in the world by volume, but it has recently acknowledged being squeezed by Chinese rivals at the low end and by Apple at the high end.

It's also worth noting that hardware OEMs generally have a poor track record in creating profitable content and services platforms, especially those with low up-front margins. There are many operational expenses associated with running platforms, and that money has to come from somewhere. That puts even more pressure on Xiaomi to offer its content and services profitably, because otherwise it's just a matter of time before it falls from grace.

Xiaomi has catered very well to China's smartphone market with localized content and optimizations. Xiaomi's Android-based MIUI interface now has an estimated installed base of 50 million, up from 30 million at the end of 2013.

Xiaomi consumers spend a lot of time using entertainment apps (five times as much as iOS users), which is where Xiaomi has focused its app efforts. Beyond apps, Xiaomi also offers a theme store, a social gaming platform, cloud storage services, a messaging app, and a browser.

The company says it generates approximately $5 million in revenue per month from MIUI. That translates into $60 million in annual revenue from Xiaomi's primary profit center, even as the company was recently valued at $10 billion.

The plot thickensLate last year, Xiaomi launched an e-book store in China, leveraging its 2012 acquisition of Duokan. Just a few months ago, Xiaomi invested $200 million in Xunlei, which operates video streaming site Kankan. Content is king, and Xiaomi knows it.

Xiaomi hired Hugo Barra away from Google primarily to lead international expansion. The company launched in Singapore earlier this year, followed by Malaysia a couple months later. Also on the expansion to-do list are India, Thailand, Vietnam, Russia, Brazil, and Mexico, among others. The challenge with expanding abroad profitably will be localizing MIUI in these markets, which is easier said than done. MIUI is available on other Android devices beyond Xiaomi's own products, which will help its scalability.

Xiaomi is an undeniable success story, and the company has executed its strategy extremely well. It could very well continue on this trajectory and remain a dominant player in the cutthroat smartphone market. But if history offers any lessons (which it usually does), it's that the odds are against Xiaomi in the long run.

Evan Niu, CFA owns shares of Apple. The Motley Fool recommends Amazon.com, Apple, Google (A shares), and Google (C shares). The Motley Fool owns shares of Amazon.com, Apple, Google (A shares), and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Evan is a Senior Technology Specialist at The Motley Fool. He was previously a Senior Trading Specialist at a major discount broker. Evan graduated from the University of Texas at Austin, and is a CFA charterholder.
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